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Trade war

China sell-off shows early US edge in trade war

Investors buy strong American economy while casting doubt on Beijing's options

The Shanghai stock market has retreated on concerns that the trade war will exacerbate other factors slowing the Chinese economy.   © Reuters

TOKYO -- The sell-off in China's currency and stock market has quickened as investors see the U.S. maintaining the upper hand in the trade conflict between the world's two biggest economies.

The yuan has fallen more than 4% against a basket of major currencies since the end of May, while the dollar has gained about 1.5%. The Shanghai Composite Index has declined 9% over the same period, hitting a nearly two-and-a-half-year low earlier this month. But the Dow Jones Industrial Average is up 3%. 

This divergence in performance began to widen in June, and Sumitomo Mitsui Asset Management sees it as a reflection of the "differing directions of the U.S. and Chinese economies."

Helped by tax cuts enacted under President Donald Trump, U.S. consumer spending is rising, and corporate activity is upbeat. China, meanwhile, is experiencing a drop in infrastructure spending and weak consumption. This, coupled with the effects of continued deleveraging, compounds the risk of an economic slowdown from increased trade friction, says Liz Young, senior investment strategist at BNY Mellon Investment Management.

Structural differences in the two economies also mean "China has a disadvantage," says Kiyoshi Ishigane, chief strategist at Mitsubishi UFJ Kokusai Asset Management.

China is more reliant on exports than the U.S. is. According to estimates by Morgan Stanley, the 25% import tax that the Trump administration has announced on $50 billion worth of Chinese goods will slow China's economic growth by 0.1 percentage point. Expanding the scope to a 10% tariff on $200 billion of imports would triple the impact to 0.3 point.

Moreover, China's ability to retaliate in kind is limited by its lower volume of imports from the U.S. Chinese imports of American goods come to about $130 billion a year, roughly a quarter of the value flowing in the other direction.

Beijing could resort to other measures, such as boycotting American products, sharply devaluing the yuan or selling off U.S. government bond holdings. But all of these options are "impractical because of the big downside for China," says Xiao Minjie, senior analyst at SMBC Nikko Securities.

Letting the yuan depreciate sharply, for example, would risk accelerating capital outflows. Many observers thus expect Beijing to eventually make concessions like increasing U.S. imports.

But the trade war may yet inflict widespread damage on the global economy so that no winners emerge. International Monetary Fund projections issued on Wednesday warn that a rise in trade friction could slow global growth by 0.5 percentage point.

Trump's inconsistent approach to economic policy is a further risk. Though he aims to cut America's trade deficit with China, raising barriers to cheap Chinese goods could stoke inflation, prompting more Federal Reserve interest hikes and a stronger dollar. Both of those effects would undermine the competitiveness of U.S. exports.

Trump has recently expressed displeasure with the direction of the Fed's monetary policy and the rising dollar, but ignoring inflation risks undercutting Americans' real wages. Either way, how long investor confidence in the U.S. will last remains to be seen.

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